Small business epitomizes the American dream. From tinkering in the basement or garage to organizing a new business at the dining room table or college dorm room, entrepreneurs have been creating their versions of the American dream since the beginning of the republic. Some of the most notable start-up businesses that began as a vision of one or more individuals and became giants include Apple, Microsoft, Dell, Amazon, Facebook, Netflix, and countless others that have become behemoths across numerous sectors of the U.S. economy. Nevertheless, small business failures, which may be overstated, are caused by many factors.1 Small business owners can improve their chances of success if they understand the vulnerabilities they may encounter and have the “entrepreneurial mindset” before they embark on their pursuit of the American dream.
A successful small business owner typically should have some knowledge of accounting, finance, marketing, and other business skills to manage effectively. Another indispensable tool or scale that small-business owners must master is “empathy.”2 Empathy is nothing less than understanding what motivates the consumer, how your product or service would alleviate his/her “uneasiness” and, in the final analysis, would provide better value than your competitors.3
The goal, therefore, of a small business owner is not to be “self-employed” but to be a value creator.4 “The role of the entrepreneurs is to figure out how to provide value to consumers and how much to charge for it.”5 The manager’s role, on the other hand, is to keep an eye on the company’s costs in order to generate profits. A small business owner’s marching orders are fairly straightforward: know your customers’ needs and goals, determine the value you can provide, and the price you can charge for your good or service, and put together a “recipe”—the business structure model—that would generate a profit. Over time, a small business could grow into a medium or large enterprise as we’ve seen in the evolution of the Amazons, Facebooks, and Apples of the business world.
A successful small business not only provides value to consumers but also helps improve the lives of workers.6 Competition among small businesses for workers, as well as competing with big-box stores and other large enterprises for talented employees, means one thing, workers are in the driver’s seat regarding salary and benefits. In fact, a case can be made that workers may be in a better bargaining position with small businesses, which may have to offer higher wages/salaries to attract talented employees. Moreover, minority and women-owned small businesses (with employees) totaled more than two million in 2017, according to the Census Bureau, the last year data were available.7 In fact, in recent years, growth of small businesses was higher in minority communities than nonminority populations.8 Owning the small business, therefore, has been, is, and will continue to be the best wealth generator for Americans—especially members of minority communities.
Vulnerabilities
Positive cash flow is to small business what air is to human beings—without it you die. New small business needs to be adequately capitalized in order to pay all its expenses and maintain its focus on creating value for customers. Once the business is up and running, the challenges are managing receivables, managing payments, especially payroll, and obtaining capital when necessary as the business grows.9 Unless a small business owner has the accounting and finance skills to run a business, he/she should hire a financial consultant/accountant to navigate the cash flow challenges during the business’ initial years. As the business grows and positive cash flow is steady, financial and accounting expertise becomes even more necessary.
Small businesses probably face the most competitive environment in our history. Businesses have to compete locally and regionally as well as nationally because of e-commerce. At the height of the holiday shopping season, customers use the Internet to compare prices to obtain the lowest price for products they are seeking. The small business, therefore, needs to differentiate its goods or services to meet the needs of customers by focusing on value. In addition, large brick-and-mortar stores carry many different products so customers can purchase everything they need in one store without having to travel to different ones. This is one of the greatest challenges facing small businesses; they cannot compete on price with Walmart or Amazon.
Another risk facing small businesses in an age of e-commerce is cyber security. Small businesses probably will not have their own IT cyber security team on site to protect their data. Without the proper precautions, they would be susceptible to ransomware attacks and hacking of their databases. A disruption in their IT systems could not only result in lost business but also open them up to lawsuits. A small business, therefore, could hire local talent either from a high school or a local college for a reasonable amount to help set up the appropriate defenses against an IT attack.
Other risks facing small businesses include interruptions from a storm, fire, or pandemic and supply chain interruptions, which would cause, for example, a manufacturing company to shut down its operations temporarily or for an extended period of time. In addition, small business owners could have a legal adviser and sufficient commercial general liability coverage to deal with wrongful employment practices, workers compensation claims, and environmental and pollution liability losses.10 An additional vulnerability of small businesses is the loss of a key employee, which could be ameliorated by purchasing key person insurance. Lastly, insurance coverage for the loss of property, equipment, and electronic data is a must in an era where e-commerce is growing markedly, especially for small businesses.
Besides all the challenges a small business owner faces during so-called normal times, the fact that we live in a business cycle economy poses additional risks. One obvious challenge for small business owner is to attract competent employees during the boom phase of the cycle when all companies are scrambling to hire additional workers. The competition for workers will tend to raise salaries, which will put a squeeze on small business profitability. A small business owner should be able to maintain his staff as long as the employees perceive moving to another company may not be in their best interests even at a higher salary. The small business entrepreneur would have to put his “managerial” hat on to keep his employees in the fold so to speak to avoid incurring greater recruiting and training costs.
When the inevitable downturn occurs, small business owners will face a different challenge, namely, how to maintain profitability, retain the necessary staff to ride out the economic storm, and then prepare for the eventual upturn in the economy.
For fledgling small business owners, one of the best places to begin obtaining the tools necessary to travel successfully on the road of entrepreneurship would be HunterHastings.com and Economics for Business (https://mises.org/library/economics-business). These free tools are invaluable for any individual who is going to take the leap into becoming an entrepreneur. These two websites provide both a theoretical framework and practical advice for entrepreneurs. Embracing the insights of Hunter Hastings, other economists, and successful entrepreneurs would provide not only information that would help them launch their business but also provide experienced entrepreneurs with the set of tools to enhance their current operations.
Fluctuations, Bailing Out, Sticking It Out, Cashing Out
Small businesses are especially vulnerable to economic downturns, especially manufacturing companies.11 Nevertheless, there are several sensible tactics a small business can use to ride out the financial storm. To recession-proof your business, Susan Ward recommends: protect your cash flow, review inventory management, focus on core competencies, win the competitor’s customers, make the most of current customers, increase rather than decrease marketing, and monitor your credit scores.12 Although there are no guarantees that a small business will survive by doing everything “right” during a recession, the probability that the company would avoid bankruptcy or liquidation would increase markedly.
Several examples of small business owners who were impacted by the great recession of 2008, but retooled/reorganized and survived include Rhys Williamson, whose fiberglass boat business revenues declined from $3m to $150k/year; he then pivoted, specializing in repair work. Robert Radcliff saw his consulting business revenue decline from $1.8m to $550k/year; he laid off his staff to stay afloat. Dida Clifton’s bookkeeping business was cut in half; she stayed in business by entering into strategic partnerships. David Stringer’s auto accessories business declined by 37 percent; to stay afloat he diversified his client pool.13 There are undoubtedly hundreds if not thousands of small business owners who had to rethink their business plans in order to survive and thrive after the Great Recession. It behooves small business owners to have contingency plans in place, as the current upswing in the business cycle is an opportune time for entrepreneurs to prepare for the next downturn.14 This can be best described as “value agility,” a process where entrepreneurs have to adapt and adjust to continue to meet consumers’ perceptions of value your business delivers.15
One of the most difficult decisions for a small business owner is whether to stick it out when the economy is in a slump or wave the white flag and close the doors. This is one of the most agonizing decisions for an individual who has spent years, maybe even decades, building a business from scratch. A key factor would be the age of the owner who does not have a succession plan in place. For example, a business owner in his or her sixties may be better off financially and psychologically to sell the business at whatever price the market will bear and then use his/her expertise as a consultant to help young entrepreneurs create a sound business plan.16 Another strategy could be making a long-term key employee(s) partners with the goal of selling them the business eventually. Or the business owner could sell the company to the employees. Employee ownership could inject new energy—and ideas—into the business. It should go without saying that small business owners need to monitor the pulse of the economy and have contingency plans in place as the economy goes through the business cycle.
The optimal time to sell a small business would be at the peak of the business cycle. This is easier said than done. Needless to say, a profitable business with a strong consumer base would allow the small business owner to “cash out” and never look back. Depending on the size of the business and the financial resources of one or more key employees who may be the potential buyer, the small business owner could hold “paper” at an interest rate lower than what a bank would charge allowing the new owners to reduce the debt service of their purchase. There are many creative ways for a business owner to cash out when the time is right.17 Timing the sale of the small business thus maybe one of the most important decisions an entrepreneur would make. An exit strategy, therefore, should be planned in advance in order to avoid making a hasty, unwise, and potentially financially unsound decision.
The Skyscraper Curse, Real Estate Bubbles, and Picking Up the Pieces
The economics and regulatory policies of big cities have made it more difficult for small businesses to survive and thrive. Big city economies—New York, Chicago, Boston, San Francisco, Atlanta, and other major urban centers—have one thread in common; they are also major financial centers, which are the earliest recipients of the Federal Reserve’s easy money policies. In other words, the boom phase of the business cycle will be especially strong in these urban hubs and their surrounding suburbs.
As the new money enters the economy in these metropolitan regions, prices tend to rise. For small businesses, that means competing in an economic environment where costs such as wages, rents, and other expenses rise faster than in outlying areas. If small businesses can raise their prices to cover their highest costs, then their profit margins should not be negatively affected. However, if small business’ prices tend to be relatively inelastic, then they will have to absorb the higher costs that they will face during boom phase of the cycle.
Small business owners also have to deal with local and state regulations that may raise their costs, which may be difficult if not impossible to pass on to their customers. The pandemic of 2020 further exacerbated small business owners who were locked down for months at a time and then only allowed to open at limited capacity.
For more than 100 years of business cycles, the so-called skyscraper curse has been observed. The “curse” shows the correlation between the building of skyscrapers and the end of the business cycle boom. The explanation is quite straightforward, namely, the Federal Reserve’s easy money policies drive down interest rates, which make these projects feasible.18
Small businesses may locate in the retail portion of a skyscraper or in surrounding storefronts on pricey streets such as Manhattan’s Fifth Avenue, Chicago’s Loop, or any other domestic or international city that has had a skyscraper constructed over the decades. The small business owner is in effect speculating that locating near the skyscraper will provide sustainable revenue—and profits. However, when the bust phase of the cycle begins, small business owners may experience the negative consequences of being located in or around an “overbuilt” commercial building.
Although the suburbs generally do not have skyscrapers because of zoning laws and the impracticality of locating such a building outside of a city, real estate bubbles popped in commercial properties and residential housing during the great recession of 2008.19
As we have previously mentioned, the old adage regarding stocks is buy low and sell high—or, as Warren Buffett explained the tops and bottoms of prices during the business cycle, “Be fearful when people are greedy and be greedy when people are fearful.” This applies to the real estate market as well when prices declined during the bust phase of the cycle and savvy investors were either cash buyers or had access to funds and picked up quality properties at a fraction of their boom phase peak. Investors who snatched up properties when the real estate trust index hit 80 have seen property prices in general quadruple before the pandemic correction caused prices to slide. With short-term interest rates remaining low but long-term rates starting to rise at the beginning of 2021, the boom phase of this cycle could last a few more years. Time will tell if the upswing in prices that have occurred since the panic low in early 2020 is the beginning of a multiyear boom or just a temporary blip.
Location, Location, Location
Is there a best or optimal location for small business? For retail businesses that require foot traffic the answer is absolutely yes. However, with the boom in e-commerce, online sales are becoming an integral component of a small business’ operations. Nevertheless, location is critical for retailing or a hospitality business; a poor location could be the death knell for a restaurant or boutique but not so important for a manufacturer, whose customers rarely have to visit the plant. The same goes for a wholesaling operation.20
The pandemic has caused some businesses to reinvent themselves or see an opportunity to take a product or service to customers. Monica Pidhorecki lost her job when the tavern where she worked (in Northern New Jersey) shutdown due to COVID-19. Now she is known as the Ice Cream Lady, serving ice cream from her truck and acknowledging, “This is the best job I’ve ever had.”21 Established businesses also have taken the truck route in order to sell their products directly to customers given the limited capacity allowed in stores and restaurants. In short, human ingenuity and flexibility have made small business owners resilient in the face of the pandemic.
Surviving and Thriving, Growing the Business, and Preserving Wealth
The business cycle is not going away anytime soon because the Federal Reserve tries to manage the economy by manipulating interest rates and thus creates distortions and unsustainable economic activity. Everybody loves an economic boom because jobs are plentiful, sales are robust, and profits are rising. But when the day of reckoning occurs (when the Fed “tightens” credit conditions to cool off an overheated economy) unemployment increases. At that time, growing—let alone maintaining—revenues is a challenge, and profits will tend to shrink or turn into losses. This is not to say that all businesses—large and small—are affected similarly. That is why it is important for small business owners to have an accurate perspective of the big picture and the possible consequences of the business cycle on their companies.
First and foremost, a small business must have adequate cash reserves throughout the business cycle to meet any contingency plans, especially when the downturn unfolds. By having adequate liquidity, a small business would be able to meet its current expenses including any debt service, during a 12-month or longer recession, which has been the average downturn in the postwar period. In addition, reducing expenses would be an essential tactic to get through a recession relatively intact. As the recession is winding down, small business owners could be in a very strategic position by purchasing assets—inventory, machinery, and so on—from competitors who are liquidating their businesses. Thus, keeping tabs on competitors during the economic downturn would be a worthwhile endeavor that would help a small business thrive during the next upturn in the economy.
There are many great success stories that occurred during the pandemic on how companies adapted and pivoted to meet the needs of customers. One such company is Eden Park Illumination, Inc. of Champaign, Illinois. Before the pandemic its one product was an ultraviolet (UV) diamond detector technology. The company rapidly shifted its production to a UV light application that would disinfect crowded spaces. By so doing, it added a dozen workers to its 10-person company.22 The takeaways from the Wall Street Journal Small Business Survival Guide (August 1–2, 2020) in light of the pandemic are that health-oriented small businesses survived and thrived: “Focus on what sells, Stay focused on what you know, Go digital, All hands on deck, Get simpler, and go small.”23 Needless to say, funds from the Paycheck Protection Program helped some of the companies profiled refocus their businesses to continue operations.
Small business entrepreneurs can grow their sales and profitability by staying focused on their customers’ needs and working with them during a bust phase of the cycle or when an exogenous factor rocks the economy, such as the pandemic did in 2020 and into early 2021. Entrepreneurial empathy will pay huge dividends for small business owners no matter what phase of the business cycle the economy is in or whether the economy is fully opened or in a partial lockdown.
Several common-sense actions would assist small business entrepreneurs to grow the business in a cost-effective way such as maximizing social media, building an effective team, and attending networking events, among other activities.24
Even before a small business becomes cash flow positive, the owner should purchase the appropriate insurance policies to protect the company’s assets from any potential lawsuit that could be financially devastating.25 Without adequate insurance, the small business owner can see his years of investment in time, energy, and financial resources virtually disappear from a calamitous lawsuit.
Avoiding the Bubble Fallout
To avoid being a casualty when a financial bubble bursts, a small business—especially a start-up or one in its early stages—should not be highly leveraged. For example, it should not have taken on a substantial amount of debt during the so-called good times. If a small business has a reasonable amount of debt and can cover the interest expense as the economy falters, it should be able to bounce back strongly—and provide breathing room to grow the business during the next upswing in the economy. On the other hand, one of the best strategies for a small business owner is to rely on equity instead of debt in the company’s early stages to avoid the burden of interest expenses during a recession.
Creativity, flexibility, ingenuity, insight, and perseverance will help entrepreneurs navigate the business cycle and other disruptions to the economy that make it possible for small business owners to “to fight another day.” The entrepreneurs who survived the great recession and were able to reinvent, in some cases, their existing businesses as the bubble was bursting reveal the resiliency of American entrepreneurs. In addition, the small business owners who faced enormous challenges during the pandemic and were able to restructure their businesses to meet the needs of customers once again demonstrate that “necessity is the mother of invention.”
Both the Great Recession and the pandemic of 2020 unfortunately caused many small businesses to close their doors forever, dashing the hopes and dreams of long-time business owners, newly arrived immigrants, and women and minority entrepreneurs.26
One of the conclusions from the pandemic is that many restaurants and foodservice businesses have poor business models—low margin, high labor costs, insufficient digitization, insufficient insulation from competition, poor cost control, and inadequate cash reserves.
Recessions and pandemics have caused incredible challenges for small business owners. However, we have enough examples of how many of them have weathered the storms that small business owners should take note. Every crisis, if prepared, is an opportunity to apply sound business practices outlined in this chapter.